VirnetX stock soars as Microsoft patent trial nears

On the surface, it sounds just like any patent-infringement claim against Microsoft: A relatively small technology company files a lawsuit in a plaintiff-friendly court and alleges a giant corporation has violated its patents for years.

UPDATED
9:23 a.m. March 8
Added information about SAIC’s involvement and VirnetX’s withdrawing of one patent claim.1:58 p.m. March 8
Added further context on SAIC’s involvement.

The difference this time, in VirnetX v. Microsoft, is that billions of dollars could be at stake.

The Silicon Valley firm says Microsoft Corp. used its patented technology for secure virtual private networks (VPNs) in Windows XP, Windows Vista, Windows Server 2003, Windows Messenger, Live Communication Server, Microsoft Office Communicator and Microsoft Office. The presiding judge in the federal case has agreed with VirnetX nearly every step of the way, effectively widening the scope of any potential infringement and putting a bulls-eye on every copy of Microsoft’s cash cows since the patents were issued in the early and mid 2000s.

As such, shareholders of VirnetX Holding Corp. have enjoyed a year of spiking prices. One can almost use the company’s stock chart as a roadmap to major developments in the lawsuit.

And as Monday’s start to the jury trial nears, VirnetX stockholders are getting excited. VHC now is six times the value it was one year ago, and a victory in the case could mean billions in future revenue from corporations beyond Microsoft.

On June 10, 2008, VirnetX sued Microsoft for allegedly infringing three of the company’s patents: No. 6,502,135 (“Agile Network Protocol for Secure Communications with Assured System Availability,” issued Dec. 31, 2002), No. 6,839,759 (“Method for Establishing Secure Communication Link Between Computers of Virtual Private Network without User Entering Any Cryptographic Information,” issued Jan. 4, 2005) and No. 7,188,180 (“Method for Establishing Secure Communication Link Between computers of Virtual Private Network,” issued March 6, 2007). Both companies confirmed that VirnetX eventually withdrew claims on one of its patents, No. 6,839,759, because it and No. 7,188,180 cover largely the same technology.

The patents originally were developed at Science Applications International Corp., a large government contractor based in McLean, Va. A number of the inventors moved to VirnetX after it acquired the patents from SAIC in 2006. The details of SAIC’s involvement were not immediately clear, but the court ordered SAIC to join the lawsuit as an involuntary plaintiff.

“The patents involve network communications and VPNs. Lots of sexy spy-versus-spy stuff around the Navy’s VPN technology,” patent attorney Cole Stuart, CEO of the Lexevia law firm in Los Angeles, told seattlepi.com in an e-mail. “You probably know about VPNs – basically encryption of communications over public networks to prevent the bad guys from snooping on sensitive communications flying around the world.”

The case is in U.S. District Court for the Eastern District of Texas – a haven for small companies looking to score patent-infringement cash from big corporations.

Scotts Valley, Calif.-based VirnetX asked for a jury trial, injunctions on infringing products, attorney fees and, of course, monetary damages. Those damages, depending on the Tyler, Texas, jury’s ruling and Judge Leonard Davis’ judgment, could range anywhere from $200 million to $6 billion – depending on who is crunching the numbers.

That’s because the products involved account for more than $300 billion in Microsoft sales. If you figure VirnetX is awarded a 2 percent cut of that – a very high figure – that’s $6 billion in damages. Even 0.5 percent would net VirnetX $1.5 billion. Plus, VirnetX would then see a continuing stream of income from Microsoft’s future sales.

“Microsoft takes some hits down there,” Henry Sneath, a Pittsburgh-based intellectual property attorney, said of the Eastern District of Texas.

Most recently, Microsoft lost a $290 million case – and an appeal – in which i4i Inc. sued the Redmond-based company over use of custom XML in Microsoft Word. The VirnetX case will be tried by the same judge in the same court with the same legal teams on both sides.

The lawsuit also features the rematch of Judge Davis versus Microsoft attorney Matthew Powers (of the firm Weil Gotshal & Manges), whose trial misconduct in the i4i case cost Microsoft an extra $40 million. VirnetX’s legal firms, McKool Smith and McDermott Will & Emery, have successfully argued nearly every major pre-trial motion and claim throughout the past two years of litigation in the case.

VirnetX’s big breakthrough came in February 2009 during a claim-construction hearing, also known as a “Markman hearing.” That’s when the attorneys and judge went word-for-word through major pieces of VirnetX’s patents, arguing how specific patent claims would be defined for the jury trial.

VirnetX’s attorneys argued that the patents should be construed in the widest possible terms, so that more Microsoft products could potentially infringe. Microsoft argued for the opposite, saying the scope of VirnetX’s patents are narrower in terms of the technologies they cover.

In a July 2009 opinion, Davis agreed with VirnetX. VirnetX stock shot up.

“Everybody gets excited when they win a Markman hearing,” said Sneath, who spoke with seattlepi.com on behalf of DRI, the nation’s largest organization of civil litigation lawyers. “But the appeal – the most common way to appeal is to strike down the (previous) claim construction.”

“No large, deep-pocket defendant wants to face a jury trial in Tyler,” he said. “Jurors in the district have a reputation for awarding enormous sums.”

During the trial, Microsoft will argue that the patents are invalid and that its products do not infringe. For one, the software superpower’s attorneys will argue that VirnetX’s patents are limited to private computer networks, not networking in general.

They will also try to convince the jury that the technology in question existed in Microsoft’s products before VirnetX patented it – an argument known as “prior art.” And though VirnetX’s victory in the Markman hearing opened a broader scope for possible infringement, it also opened up a broader potential for prior art.

“In essence, you can’t patent something somebody else already invented, or something that was ‘obvious’ – a legal term that is currently an evolving legal issue in patent law – from the existing technology at the time of the invention,” Stuart said. “Obviousness usually comes down to a battle of experts at trial.”

In a March 3 court filing, Microsoft’s attorneys said they plan to argue that VirnetX’s patented technology is “invalid for obviousness in light of the prior art” of Microsoft VPN technology in Windows NT 4.0, Windows NT 5.0 Beta 2, Windows 2000 Beta 3, Gauntlet Firewall and other pre-existing Microsoft and non-Microsoft products.

They also will most likely mention that the U.S. Patent and Trademark Office is re-examining one of VirnetX’s patents. Microsoft sought the reconsideration, but USPTO re-examinations are getting more commonplace and do not automatically suggest a patent is invalid.

A verdict from the jury is expected in about two weeks. It could take Davis – who worked as a computer programmer and systems analyst before entering law – several more months to come down with a final judgment.

“We are confident the evidence will show we do not infringe and the patents in question are invalid,” Microsoft legal spokesman Kevin Kutz said. “We look forward to the start of the trial.”

VirnetX spokesman Greg Wood said his company declined to comment.

If VirnetX wins the lawsuit, Microsoft is all but certain to appeal Davis’ decision to the U.S. Court of Appeals for the Federal Circuit. Though a three-judge panel there recently upheld the i4i verdict against Microsoft, the software juggernaut could have better chances with the patent-savvy Federal Circuit.

“Microsoft faces another potentially huge verdict against it,” Stuart said. “But given their track record and the ability to appeal the case to the Federal Circuit in D.C., which will likely be a more friendly forum for Microsoft, they’ll probably roll the dice.”

If eventually upheld, a VirnetX victory against Microsoft could open the floodgates for subsequent cases against other companies that might infringe the patents. These could include such giants as Cisco, Google, Hewlett-Packard, Siemens, AT&T, Juniper, Qualcomm, VeriSign, NEC, Verizon and many others.

That’s why VirnetX shareholders are so excited about this case. They smell greenbacks – and lots of them. But Monday’s trial is just the beginning of what is sure to be a long legal fight that could span many courts and many years.